Tuesday, December 15, 2015

Non-Performing Loans And Fairness

The four large Greek banks, supervised by the ECB, will need to make very substantial write-off's on their loan portfolios in the next years.  Roughly half of all their loans are non-performing (107 BEUR at the ECB's last count). At this point, there are wild guesses as to how much of that 107 BEUR will eventually have to be written off.

Loans are an asset of a bank and a liability of a borrower. When a lender writes off an asset, he takes a loss (because he doesn't get the money which is due to him) while the borrower registers a gain (because he doesn't have to pay everything he owes). The lender's loss is material. The borrower's gain is not when he truly does not have the money to pay the lender. An overdebted borrower does not benefit when the debt which he truly can't pay is reduced.

There are essentially 3 ways in which a bank can resolve non-perfoming loans which have no chance of ever returning to full performing status:

1) Initiate bankruptcy proceedings.
2) Negotiate settlements with borrowers.
3) Sell the loans to a specialized fund at a deep discount.

Bankruptcy proceedings can assumed to be fair because they are under a court's supervision: an official administrator liquidates the borrower's assets and pays off the lenders with the proceeds. If the proceeds are less than the bank's claims, the bank's loss is fair and the borrower has no undue benefit. Regrettably, bankruptcy is always the most expensive solution for all parties involved and, typically, substantial economic value gets destroyed. The only question is whether the borrower's assets in the bankruptcy proceedings are his 'true assets' which leads to the following two disclaimers.

First, the old saying is that "the company is bankrupt but its owner is rich". Why? Because the owner had taken up debt in the name of his company and - through various legal or non-legal tricks - had milked the company, enriched himself personally while leaving the company worthless (as long as the owner had not issued any personal guarantees). That is an extreme case of unfairness but no legislation has yet been found which could counter such conduct (unless fraud could be proven).

Secondly, in the case of personal bankruptcies, the husband/borrower may truly present himself as a pauper whereas his wife is living in a palace and driving the Ferrari, both of which were bought with loans the husband had taken up. Again, there is no legislation against such conduct (unless fraud could be proven).

Selling loans to a specialized fund is the easiest (but probably costliest) way out for a bank: a deal is closed, a price is paid and the bank will never again have to think about these loans. From the borrower's standpoint, it is the worst solution of all. The borrower no longer faces his relationship banker at the negotiating table. Instead, he is looking straight into the eyes of liquidators who want to see cash. And fast! Still, selling loans is a 'clean' solution in the sense that no fund will pay more than it thinks the loans are worth and if the selling bank thinks the fund offers too little, it doesn't have to sell. In short: transparency and voluntariness all around.

Negotiated settlements are deals where the bank forgives part of the debt in exchange for something. That 'something' is typically a plan by the borrower as to how he can return to profitable operations once the debt is reduced. In this case, the bank voluntarily writes off some debt and takes a loss, while the borrower has significant benefits (above all: he stays in business and his debt load has been reduced to reasonable levels). In short, here the borrower truly gains.

And this is where unfairness can easily come into play. Suppose the 4 banks decide to set aside 20 BEUR for settlements on the 107 BEUR non-performers. It is not a computer which will determine which borrowers will get that benefit. Instead, it is human beings who will take those decisions. Human beings with friends and acquaintances, with networks, with shared political interests, etc.

There are undoubtedly very many borrowers out there who are already vying for a piece of that settlement cake. Some will spend their efforts to prepare restructuring plans for their business but there are a lot of borrowers who, instead of preparing plans, will lobby their networks to influence bankers' decisions. And who knows? A borrower who is forgiven, say, 20 MEUR might be quite disposed to transfer, say, 2 MEUR to the private offshore account of his banker. Or does this seem far-fetched?

To be sure, Greek bankers are not totally free to arbitrarily distribute gifts to their friends and acquaintences. They are being supervised by the ECB and the hedge fund owners will also be keenly interested to assure that the value of their investment is not damaged. But, still, there will be room for manouvre and the situation should be watched closely.


  1. Thank You Mr. Kastner On Giving Some Clairty on this foggy issue.

    It does not affect me directly but i am trying to see if there will be fairness in all of this issue, against people who are directly affected by this. Why? Because if i am not mistaken the losses the banks will take on this issue, will need to be recapitalized, hence more loans which will fall on us tax payers. Right?

    I don't like the first option for businesses which can go to Bankruptcy proceedings, because i fer many cases of personal wealth trasnfered by ailing businesses. I still do not understand why no legal structure has been created to go after owners personal wealth.

    Selling the loans, which is tranlated in greece as loans being sold to the crows and loan sharks. Is it really this? For example a home owner will no be in this position to negoatiate payment issues with these funds? Or companies?

    I like the last option which will be regulated under the ecb. But in a manner that will be properly overlooked and proper renegotiations will be made.

    From my understanding through the news, the loans will be split into two categories. A large chunk will be sold to funds and a smaller group will be renogiated.

    Whatever the case or the solution, "the knife has to hit the bone" on this issue as so banks can start loaning responsibly again. I believe that after this crisis, bankers in greece will be extremely cautious in how they issue loans. God willing.


    1. What I called a "spezialized fund" could also be a domestic bad bank and such a bad bank micht taker a longer-term view when striking deals with borrowers.

      An international fund wants to maximize the present value of the cash he receives. He will always make a comparison of the present value if he liquidates the claim today with brutal force and compare it with the present value in the increased risk by negotiating longer repayment schedules. In case of doubt, the higher present value wins. No other considerations.